Review of 2020
Can sceptics of tech stock valuations find more promising opportunities?
Pier Analysis examined 17 companies during 2020. How did we do? The turn of the year presents a good opportunity to find out. We will do so by seeing what would have happened to an investment of £1000 in each of them, made on the day the article concerning it was published.
Health warning
World stock markets fell sharply in the first quarter of 2020 as realisation dawned that Covid was on the way. Only two of the articles were published during that time. The rest were written afterwards, over a period in which markets recovered lost ground. Even a randomly selected portfolio would have shown respectable gains during this period.
How we did
The approach in Pier Review has not been to give firm buy or sell recommendations, but to compare what each business has achieved in the last five years with what it needs to accomplish in the coming years if buying a stake in it is to make any sense at the current valuation. Readers are expected to reach their own conclusions on how plausible that projection is.
It is, though, not hard to work out what Pier Analysis thinks. Three companies were clearly described as having valuations that could be justified by plausible extrapolations of their cash flows, being
Rio Tinto
Vodafone
Royal Mail.
In each of these we will track our notional £1000. In addition, we devoted a lot of attention to the Faatman stocks (Facebook, Alphabet / Google, Amazon, Tesla, Microsoft, Amazon and Netflix) and Zoom. While we judged all of those wildly overvalued, we concluded that if you did want exposure to this group, the one that was least expensive was Facebook. Given the half-hearted tone of the suggestion, we will put £500 rather than the full £1000 into this company.
The resulting portfolio would have risen by 37% between publication and 6 January 2021.
What, though, of the counter-portfolio, made up of the companies that we judged too highly valued to be attractive? A similar investment of £1000 in each of them, plus the £500 previously held back from Facebook, would have risen even more, by 51%.
Against the obvious inconvenience of this result, we can say
An oracle is valuable even if it consistently gives the wrong answer, by giving a reliable guide to what not to do.
The 37% increase is supported by the generation of cash flows that have every prospect of returning and rewarding an investment. The stock market could shut tomorrow and shareholders would still be likely to earn their target rates of return by waiting patiently for dividends.
The 51% is supported by no more than the willingness of other participants in a frothy market to buy shares from current holders at ever-rising prices. If those buyers disappeared, forcing shareholders to depend on the underlying cash flows, they would find the pickings slim.
The picture changes if we notice that 49.3% of the increase in the value of the anti-portfolio results from just one share, Tesla. Even those who find no difficulty with other tech stocks agree that extraordinary circumstances surround that company. Omit it and the increase in value of the counter-portfolio is 28%.
That outperformance is concentrated in a small number of shares is a well documented phenomenon. It applies to the portfolio that we thought had justifiable valuations too. Over 80% of its increase in value came from one share, Royal Mail.
In IRR terms, the gains are higher, because the articles were published between 16 Feb and 18 Dec, leaving in all cases less than a year for the results to be assessed, in the later cases much less than a year:
129% for the portfolio that we concluded to have justifiable valuations
87% for the counter-portfolio excluding Tesla
153% for the counter-portfolio including Tesla.
What we said about the different companies
Click on the company name to read the relevant article.
To justify its current valuation, one has to believe that the company will break away from the prudent and purposeful practices that have characterised it and will make a dash for expansion at a rate closer to 40% than the 9% it has consistently pursued.
Published: 18 Dec Performance since: Flat
We end up with a firm full of good news, obscured by large and adverse cash flows coming from an opaque banking division in which the firm has so little interest that it says almost nothing about it.
Published: 1 Dec Performance since: Flat
The question comes down to whether the improving cash flows and the tower IPO mark a permanent break from the uninspiring past. At the current appealingly low valuation, we would be inclined to make that bet
Published: 16 Nov Performance since: Flat
Recent rumour has suggested that plans are being assembled to bid for BT. There must be some price at which these ideas make sense, but betting that someone will step forward to move ahead with them is a speculation rather than any form of investment.
Published: 30 Oct Performance since: Up 37%
For their investment to be justified, buyers of the shares need to believe that Netflix can move its margins from the negative territory where they lie in cash terms to something more positive. This scenario ... makes no sense ... since companies aren't in the business of halving their operating costs overnight. And Netflix is clear that it has no interest in stopping what it is doing.
Published: 23 Sep Performance since: Up 11%
To deliver our target return of 10% pa over a fifteen year period, Microsoft would have to grow its cash flows at 46% pa. There is neither enough certainty that this will come to pass, nor any allowance for things go wrong on the way, to consider a bet on Microsoft as anything other than a speculation at current prices.
Published: 11 Sep Performance since: Up 4%
Facebook is closer to justifying its current valuation, against Pier Analysis's intentionally severe criteria, than are any of the other technology stocks that we have covered.
Published: 4 Sep Performance since: Down 4%
Alphabet is a fine company, one whose valuation has been bid up to a point that makes sense only to those with animated opinions about the company's prospects.
Published: 28 Aug Performance since: Up 3%
Spending money it hasn't got to pay dividends and buy back shares from current and past employees.
Published: 18 Aug Performance since: Flat
What FedEx needed to do to justify its share price in March was not implausible, though it would have taken courage to act on it then because it was at the peak of virus-induced uncertainty. Now that the share price has doubled, what it needs to accomplish is much more of a stretch.
Published: 11 Aug Performance since: Up 30%
The opportunities available to DX are fully reflected in the price already for anyone who shares our required rate of return and time horizon
Published: 7 Aug Performance since: Up 128%
Is this future plausible? Pier Analysis's instinct is that it's not obviously implausible.
Published: 24 Jul Performance since: Up 103%
We offer this note as [evidence that it] is possible to find businesses with valuations that are relatable to the underlying economics.
Published: 24 Jun Performance since: Up 35%
Zoom is a quite wonderful service, but using the criteria that appeal to Pier Analysis, it is overvalued by a factor of something approaching 15 times. Buying a stake in it is not an investment, but a speculation that other investors will continue to display this hard to rationalise behaviour.
Published: 21 Jun Performance since: Up 47%
[Current valuation] is asking the largest company in the world get almost ten times bigger. Perhaps it can manage that. Anything is possible. But betting on it is not an investment; it's a speculation, and there are safer bets elsewhere in the market.
Published: 10 Jun Performance since: Up 22%
Could Tesla hit a medium-term cash flow target of 35? Of course it could. Anything is possible. But is it likely, or even plausible? ... There is nothing in recent cash flows to give confidence that this might happen. As things stand, Tesla is not an investment, but a speculation that the conjecture that it can capture a large slice of the world's transportation industry turns out to be true.
Published: 20 Feb Performance since: Up 337%
Apple is priced as a growth stock. It would be great if it was actually growing.
Published: 16 Feb Performance since: Up 64%
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Notes
Article corrected on 11 Jan 2021 to show that DX (Group) plc is up 128%, not 28% as first written. Thanks to Roger Mayhew for noticing that the leading digit had gone missing.